## Social Indicators ## Source details **Canonical URL:** [Social Indicators](https://www.imf.org/-/media/files/publications/cr/2018/cr1854.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr1854.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr1854.pdf.json) --- ### Context and vulnerabilities - Economic volatility driven by external spillovers: - Customs revenues pooled at the Southern African Customs Union (SACU) level and dominated by South Africa’s import demand, exposing Lesotho’s fiscal revenues to external volatility. - Remittances directly affected by South Africa’s economic conditions. - Exports concentrated in diamonds, textiles, and water, increasing volatility. - Political fragility and security incidents: - Decades of political fragility and military interference; 2017 elected four party coalition—the third government in five years. - SADC reform recommendations after the 2014 attempted coup; recent killing of the army commander prompted SADC military deployment at government request. - Social indicators: - Average growth of 4.1 percent over the past decade has not reduced unemployment; poverty remains high. - HIV/AIDS rate: 23 percent. - Policy response and buffers: - Expansionary fiscal policy shielded the economy from a large SACU revenue shortfall (around 7 percent of GDP compared to the FY 2014/15 peak), but buffers have dwindled. - Recent macro developments: - Real growth averaged 3 percent over the last three years, driven by textile manufacturing and recovery of agriculture after the 2015–2016 droughts. - Over the next three years, growth expected to be driven by diamond mining and construction of the Lesotho Highlands Water Project Phase II (LHWP II). - LHWP II: expected to start in 2018 after governance-related delays; off budget; expected completion by 2022 with total costs of $1.5 billion, equivalent to 57 percent of GDP; increase in imports during construction broadly neutral for reserves because South Africa finances the project through capital grants. - Inflation and external position: - Inflation peaked at 6.2 percent in March 2017. - Current account deficit widened to 7.4 percent of GDP in FY 2016/17 from under 5 percent the prior year. - International reserves import coverage declined from a 6-month peak in March 2016 to around 4 months by March 2017. - External position broadly in line with medium-term fundamentals and desirable policies. - Fiscal stance and banking: - Fiscal deficit around 6 percent of GDP for two consecutive years financed by drawing down government deposits at the CBL, mirrored in loss of international reserves. - Banking system generally sound and stable; NPL around 1.6–1.7 percent in Q1–Q2 2017; system highly liquid holding around 1/3 of deposits as short-term foreign assets with South African parent companies. - Credit to private sector grew barely in line with inflation in FY 2016/17; formal financial access remains low. ### Outlook and risks - SACU revenue and reserves: - Projected SACU revenue shortfall deepening; reserve coverage projected to drop to 3.6 months of imports by end of current fiscal year versus optimal around 4½ to 5 months. - SACU revenue recovery anticipated only by FY 2020/21. - Without decisive fiscal adjustment, government deposits for deficit financing would be depleted during FY 2018/19. - Growth prospects and external shocks: - Growth prospects tilted to the downside except for positive effects from large foreign-financed projects. - Fiscal adjustment now would weaken short-term growth; delay would force more drastic adjustment later. - Growth impulse from mining and LHWP II expected to create temporary employment during construction. - External risks channeled via South Africa; lower global growth or SA political tensions could delay SACU recovery and affect AGOA-related textile exports. ### Policy priorities (high level) - Establish a fiscal framework ensuring sustainability under external shock vulnerability and the Common Monetary Area peg to the Rand, while protecting the poor. - Improve conditions for private sector employment and inclusive growth, including advancing financial sector reform and access to finance. - Continue efforts to reduce the wage bill and improve spending efficiency; protect social spending for the poor. *IMF staff summary of Lesotho: context, vulnerabilities, outlook, and fiscal policy options as presented in the source document.* --- ### Fund Staff Emphasis on Wage Bill Reductions ### Recommended measures and estimated savings - Continue wage bill reduction efforts initiated in the FY 2017/18 budget; government decision pending. - FAD technical assistance estimated savings from a package of measures: - Temporary hiring freeze for the next two fiscal years: saves 0.4 points of GDP. - Limiting cost of living adjustment to half the rate of inflation between FY2019/20 and FY2022/23: cuts wage bill by 1.5 points of GDP in five years. - Linking “notch” increases to performance and limiting them to one out of three workers: reduces wage bill by 1.3 points of GDP by FY2022/23. - Authorities working to complete an effective establishment list; World Bank biometric audits to resolve ghost worker issue. - Authorities considering a cost of living adjustment for FY 2018/19 below the inflation rate. ### Sectoral spending inefficiencies and potential cuts - Education: - Wage bill in education accounts for more than a third of government wage bill. - Primary school teachers’ average wage is 8 times per capita GDP in Lesotho versus 3 in South Africa. - Starting salaries 30 percent higher for teachers with a college diploma in education without higher responsibilities. - Health: - Health expenditure almost doubled in the last decade but outcomes have not improved; spending over 8 percent of GDP with weak outcomes. - Identified issues: low quality of services, lack of equipment, lack of skilled staff and commodities, weak referral system. - “Test and treat” program announced to address HIV. - Other inefficiencies: - Student loans cost 2 percent of GDP; means testing and stronger recovery could reduce this. - Goods and services slack including travel and car fleet expenses equivalent to 3 percent of GDP. - Travel subsistence accounts for more than 5 percent of goods and services with very generous per diems. ### Public Financial Management (PFM) reforms - PFM reform priorities (FAD TA condensed plan): - Reconcile accounts and improve monitoring of numerous accounts in commercial banks; move to a Treasury Single Account. - Address IT problems with the CBL’s Core Banking System. - Improve commitment control and cash management to ensure timely payments and reduce arrears. - Upgrade the IFMIS system with World Bank support. - Government tightened procurement to limit circumvention of procedures to exceptional legal cases. --- ### Revenue Mobilization, Debt Space, and Financing Options ### Tax policy measures and revenue potential (IMF staff estimates) - Introducing levy on alcohol and tobacco: 200 million Maloti, 0.5 percent of GDP. - Raising levy on gasoline: 300 million Maloti, 0.8 percent of GDP. - Aligning VAT rate for telecoms and electricity to 14 percent: 180 million Maloti, 0.5 percent of GDP. - Total potential from these measures: 680 million Maloti, 1.8 percent of GDP. ### Tax administration and immediate revenue potential - New LRA Board appointment; reconciling tax payments via banking system to phase out cash payments. - Address CIT shortfalls from large taxpayers via better monitoring and interest charges on delayed payments; for mining, establish automatic data exchange between LRA and Ministry of Mining. - Strengthen risk management and IT (ASYCUDA outages on customs; manual risk management in tax administration). ### Debt sustainability and financing space - DSA indicates low risk of debt distress in 2017, creating scope to ease fiscal adjustment by mobilizing additional external financing with a high grant element. - Government negotiating externally financed infrastructure using concessional external debt; staff and authorities agreed to preserve a relatively high grant element. - Millennium Challenge Corporation re-selection in December 2017 opens avenue for significant grant financing. - Domestic debt low (~3 percent of GDP in 2016) — scope for domestic borrowing but requires sustainable fiscal policy and improved debt management. - Authorities cautious on domestic borrowing due to borrowing cost containment; need predictable bond issuance program to develop domestic market. --- ### Monetary Policy and Financial Sector Measures ### Monetary policy constraints and tools - Margin for monetary policy limited under the Common Monetary Area. - CBL T-bill issuance capped at 700 million maloti and usually oversubscribed; staff encouraged raising cap to 1 billion maloti to mop up liquidity and induce repatriation of liquid assets; authorities welcomed proposal pending further discussion. - Revision of liquid asset requirement (LAR) regulations recommended because current rules allow gross claims against each other as liquid assets, weakening constraint. ### Financial stability and inclusion - Bank resilience: - CBL stress test using end-2016 data: 30 percent of performing loan portfolio would have to become non-performing to breach 8 percent minimum CAR; NPL 1.6 percent as of Q2 2017. - Even if all highly indebted civil servants defaulted, additional NPLs would be less than 10 percent of the loan portfolio. - Household indebtedness: - Authorities applied a 70 cap on payroll deductions to address high civil servant indebtedness; staff suggested exploring options to gradually reduce this cap to phase out payroll deduction system. - Credit bureau established in 2016 improving information to lenders. - Financial intermediation constraints: - Banks’ preference for highly liquid assets dampens intermediation; reasons include business environment constraints and need to maintain convertibility of loti deposits into Rand. - Prudent fiscal policy preserving high international reserves would support financial intermediation. - Mobile money and inclusion: - Mobile money services growing fast; CBL regulates lightly to foster reach and reduce costs while monitoring risks. - Post Bank and banks plan mobile solutions; Post Bank expects to launch micro savings and borrowing application. - Daily cap on mobile payments in Lesotho: 195 USD (2,500 maloti daily and 10,500 maloti weekly). - Comparative daily caps: Tanzania 1,775; Uganda 1,300; Kenya 1,250; Ghana 300; Nigeria 300. --- ### Fiscal Scenarios, Adjustment Needs, and Key Projections ### Scenario comparison (Text Table 2 summary) - Scenario 1 (baseline, limited adjustment): - Revenue measures: levy on alcohol and tobacco (spread over FY 2018/19 and 2019/20) and gradual tax administration improvements. - Wages decline in percent of GDP in FY 2018/19 in line with previous budget measures. - Moderate reduction in capital spending. - Liquid government deposits fall to zero in FY 2018/19; new domestic borrowing assumed to increase with rising interest expenses; arrears likely to accumulate. - SACU recovery in FY 2020/21 would turn fiscal deficit broadly balanced; CBL reserve coverage would level out at around 2 months of imports. - Scenario 2 (substantial policy adjustment): - Revenue measures: increase VAT rate on electricity and telecommunications and increase fuel levy. - Expenditure: steady reduction in share of wages in total spending; additional savings from cuts in goods and services; reduction in domestically-financed capital expenditures. - Deficits fall to around 2 percent over next two fiscal years and turn to surpluses when SACU revenues recover. - Reserve coverage stabilizes in FY 2018/19 and recovers to 4 months of imports by FY 2021/22. - Total five-year adjustment would reach 9 percent of GDP; could be eased with additional development partner financing. ### Key scenario numerical excerpts (as presented) - GDP at constant prices (percent change) Scenario 1 (2016/17–2021/22): 3.1 3.1 1.7 2.6 2.1 2.9. - Gross international reserves (Months of imports, excluding imports for LHWP-2): - Scenario 1: 4.2 3.6 3.1 2.5 2.2 1.9. - Scenario 2: 4.2 3.7 3.7 3.5 3.7 4.0. - Overall balance (percent of GDP): - Scenario 1: -6.3 -6.5 -5.3 -4.9 0.4 0.3. - Scenario 2: -6.3 -6.5 -1.9 -2.1 5.0 4.7. - Cumulative adjustment need (percent of GDP): - Scenario 1: -3.3 0.5 3.2 4.2 4.2. - Scenario 2: -3.3 4.0 6.0 8.7 8.7. - Note: Fiscal year runs from April 1 to March 31. ### Fiscal space and composition of adjustment - Total adjustment need around 9 percent of GDP over five years under ambitious scenario. - Quantified tax policy measures would contribute around 2 percent of GDP. - Wage bill savings could contribute around 3 percent of GDP. - Recurrent spending close to 38 percent of GDP with severe spending inefficiencies; authorities agree bulk of adjustment must come from expenditure side. --- ### Debt Sustainability, Reserves, and External Sector Findings ### Debt sustainability (Annex VI highlights) - Risk of external debt distress revised from “moderate” in 2015 to “low” in 2017 due to GDP rebasing, solid GDP growth, and revisions to borrowing assessment. - Baseline: PV of external PPG debt-to-GDP reaches around 24 percent by 2020, below 40 percent threshold. - Stress tests: large negative export shock is main risk; even extreme simulated shocks keep debt ratios below thresholds in many simulations. - Domestic debt low (~3 percent of GDP in 2016); contingent pension liabilities add about 3.5 percentage points of GDP in PV terms. - Total public debt declined from 41.3 percent of GDP in 2015 to 35.4 percent in 2016. - Financing assumptions: grant element in new borrowing assumed high (42 percent); government planning to borrow US$45 to 50 million per year for projects. ### Reserve adequacy (Annex V highlights) - Reserves peaked at US$1.1 billion in August 2014. - Reserves at end-August 2017: US$864 million, ~four months of prospective imports. - Optimal reserves estimated at around 4.7 months of imports. - Traditional metrics: reserves above minimum thresholds (3 months of imports; 100 percent of short-term debt; 20 percent of broad money). ### External sector (Annex IV highlights) - External position weakened in 2016/17 due to a steep drop in SACU transfers (~7 percent of GDP) and lower diamond exports; nevertheless broadly in line with fundamentals. - SACU transfers: - Dropped by almost half in FY 2016/17 compared to FY 2014/15 peak of 24 percent of GDP. - Lesotho’s imports ~90 percent of GDP; financing highly dependent on SACU transfers. - SACU transfers projected to recover with South Africa’s cyclical upswing, bottoming out only in FY 2019/20. - EBA-lite current account norm: 6.6 percent of GDP; FY 2016/17 current account deficit: 7.4 percent of GDP; conclusion: exchange rate broadly in line with fundamentals. - Competitiveness: Lesotho among worst ranked SACU members in 2017 Ease of Doing Business and 2016-17 Global Competitiveness Report. --- ### Growth, Inequality, and Structural Constraints (Annex VII) ### Growth characteristics - Since 2007, average real growth: 4.2 percent. - Real per capita GDP rose by more than 50 percent since 2007. - Growth is narrow and volatile, driven by public sector activity financed by SACU transfers, diamond mining, and large capital projects. - Manufacturing (textiles) value added declined by almost 7 percentage points of GDP since the 2004 peak. ### Social outcomes and labor market - Poverty: poverty rate (percent, 2011 est.): 57. - Inequality: “among the highest in the world”. - Employment: subsistence farming employs over 40 percent of workers while only 10 percent of land suitable for cultivation. - Human capital: literacy deteriorated by 7 percentage points over the last 15 years; health and education outcomes weak relative to peers. ### Binding constraints to private-sector-led, employment-rich growth - Low returns to investment identified as more binding than high cost of finance. - Financial sector: loan-to-deposit spreads very high; private credit to GDP very low; banks prefer investing liquidity in South Africa. - Infrastructure deficits: only 22 percent of roads paved; poor electricity access. - Policy implications: improve investment climate, address infrastructure and human capital gaps, strengthen PFM, reduce political fragmentation, facilitate access to finance for SMEs, and leverage regional integration. --- ### Risk Assessment Matrix (Annex I highlights) ### Global risks - Tighter and more volatile global financial conditions; Relative Likelihood: Medium; Relative Impact: Low; remedial policy: advance structural reforms to increase competitiveness and diversification. - Weaker-than-expected global growth; Relative Likelihood: Medium; Relative Impact: Medium; remedial policy: advance structural reforms. ### Domestic risks - Continued political instability; Relative Likelihood: High; Relative Impact: High; remedial policy: produce roadmap for SADC recommendations by end-November deadline and implement reforms. - Insufficient fiscal adjustment to SACU transfer decline; Relative Likelihood: High; Relative Impact: High; remedial policy: implement fiscal consolidation and seek concessional financing. --- *Source: cr1854 - IMF staff appraisal and annexes as presented in the source document.* ### 1. Social Indicators _______________________________________________________________________________ 20 ### 1. Social Indicators ### Context: High vulnerabilities amidst political fragility - Economic performance subject to spillover-driven volatility: - Customs revenues are pooled at the Southern African Customs Union (SACU) level and dominated by South Africa’s import demand, making Lesotho’s fiscal revenues subject to considerable external volatility. - South Africa’s economic conditions directly affect remittances. - Exports concentrated in diamonds, textiles, and water, increasing volatility. - Political fragility and military interference: - Lesotho has experienced decades of political fragility and military interference; in 2017 a new four party coalition government was elected—the third government in five years. - Ambitious political reforms are guided by Southern African Development Community (SADC) reform recommendations after the 2014 attempted military coup; recent killing of the army commander by officers prompted SADC member countries to deploy military at the government’s request. - Social and development indicators: - Strong average growth of 4.1 percent over the past decade has not reduced unemployment; poverty remains high. - HIV/AIDS rate is 23 percent. - Policy response and buffers: - Authorities’ response to past policy advice has been mixed. - Expansionary fiscal policy shielded the economy from a large SACU revenue shortfall (around 7 percent of GDP compared to the FY 2014/15 peak), but buffers have dwindled, generating severe vulnerabilities. - Recent macro developments: - Real growth for the last three years averaged 3 percent, driven by textile manufacturing (benefitting from Rand/dollar depreciation) and recovery of agriculture after the 2015–2016 droughts. - Over the next three years, growth expected to be driven by diamond mining and construction of the Lesotho Highlands Water Project Phase II (LHWP II). - LHWP II: expected to start in 2018 after governance-related delays; project off budget; expected completion by 2022 with total costs of $1.5 billion, equivalent to 57 percent of GDP. Increase in imports during construction broadly neutral for stock of international reserves because South Africa finances the project through capital grants. - Inflation and external position: - Inflation peaked at 6.2 percent in March 2017, mainly from higher food prices after the droughts. - Current account deficit widened to 7.4 percent of GDP in FY 2016/17 from under 5 percent of GDP the previous fiscal year. - International reserves import coverage declined from a 6-month peak in March 2016 to around 4 months by March 2017 due to South Africa spillovers, depreciation of CBL’s Rand holdings, and expansionary fiscal stance. - External position remains broadly in line with medium-term fundamentals and desirable policies (Annex IV). - Fiscal response to SACU shortfall: - Government allowed fiscal deficit to increase; lower-than-expected domestic revenues in first half of FY 2017/18 added to revenue shortfall. - Fiscal deficit of around 6 percent of GDP for two consecutive years financed by drawing down government deposits at the CBL, mirrored in loss of international reserves. - FY 2017/18 budget measures to contain wage bill were broadly offset by higher recurrent spending to raise old-age pension. - Banking and financial sector: - Banking system generally sound and stable; limited impact on economic growth; formal financial access remains low. - Non-performing loans (NPL) fairly stable at low levels; profitability high though declining. - Banking system highly liquid, holding around 1/3 of deposits as short-term foreign assets with South African parent companies. - Credit to private sector grew barely in line with inflation in FY 2016/17. - Bank lending concentrated on private resident households (most uncollateralized); system exposed to household financial health; payroll debt-service deductions widely used. - Credit bureau introduced in 2016 improved information to lenders. - Non-bank financial institutions constitute around half of the financial sector’s assets; supervision infrastructure revamp delayed due to parliamentary approval lags. ### Outlook and risks - SACU revenue shortfall projections: - Projected to deepen further over next two years; reserve coverage projected to drop to 3.6 months of imports by end of current fiscal year, compared to an optimal reserve level of around 4½ to 5 months (Annex V). - Projections anticipate SACU revenue recovery only by FY 2020/21. - Without decisive fiscal adjustment measures, government deposits available for deficit financing would be depleted during FY 2018/19. - Growth prospects and risks: - Growth prospects tilted to the downside except for positive effects from large foreign-financed investment projects. - Fiscal adjustment (expenditure cuts) would weaken short-term growth; without adjustment, arrears accumulation and rising uncertainty would drag on medium-term growth. - Delay in measures could force drastic and disorderly adjustment later with negative spillovers to real economy and financial sector. - Growth impulse from mining and LHWP II expected to create temporary employment during construction phase. - Scope exists to increase external financing with sizable grant element for high quality public infrastructure to mitigate fiscal adjustment’s drain on growth. - External risks channeled via South Africa: - Lower global growth and higher global financial volatility would weigh on South Africa and delay SACU revenue recovery. - South Africa’s slow structural reform progress and political tensions could negatively impact long-term SACU revenue trend. - New government’s efforts reduced immediate risk to AGOA preferential access, but Lesotho’s export concentration in textiles remains an additional risk. ### Policy discussions and priority reforms - Priority reforms discussed: - (i) Establish a fiscal framework ensuring sustainability under external shock vulnerability and the Common Monetary Area (CMA) pegged to the Rand, while protecting the poor. - (ii) Improve conditions for private sector employment and inclusive growth, including advancing financial sector reform and access to finance. - Fiscal consolidation discussions productive but political consensus difficult. - Implementing Fiscal Consolidation — Size of macroeconomic imbalances: - Restoring fiscal sustainability is formidable given political fragility, weak institutions, high poverty and inequality. - Country at low risk of debt distress (Annex VI), but financing pressures significant. - Government faces further SACU revenue decline in FY 2018/19 and indications of further drop in FY 2019/20. - Scenario comparison (Text Table 2 summary): - Scenario 1 (baseline, limited adjustment due to political fragility): - Revenue measures include levy on alcohol and tobacco (spread over FY 2018/19 and 2019/20) and gradual tax administration improvements. - Wages expected to decline in percent of GDP in FY 2018/19 in line with previous budget measures. - Moderate reduction in capital spending incorporated. - Liquid government deposits fall to zero in FY 2018/19; new domestic borrowing assumed to increase with rising interest expenses; arrears likely to accumulate affecting growth. - SACU recovery in FY 2020/21 would turn fiscal deficit broadly balanced; CBL reserve coverage would level out at around 2 months of imports. - Scenario 2 (policy adjustment scenario with substantial measures): - Revenue measures include increase in VAT rate on electricity and telecommunications and increase in fuel levy. - Expenditure-side: steady reduction in share of wages in total spending; additional savings from cuts in goods and services; reduction in domestically-financed capital expenditures relative to baseline. - Deficits fall to around 2 percent over next two fiscal years and turn to surpluses when SACU revenues recover. - Reserve coverage stabilizes in FY 2018/19 and recovers to 4 months of imports by FY 2021/22. - Total five-year adjustment would reach 9 percent of GDP; could be eased if additional development partner financing is secured. - Key scenario numerical excerpts (as presented): - GDP at constant prices (percent change) Scenario 1: 3.1 3.1 1.7 2.6 2.1 2.9 (covering 2016/17–2021/22 in table layout). - Gross international reserves (Months of imports, excluding imports for LHWP-2) Scenario 1: 4.2 3.6 3.1 2.5 2.2 1.9; Scenario 2: 4.2 3.7 3.7 3.5 3.7 4.0. - Overall balance (percent of GDP) Scenario 1: -6.3 -6.5 -5.3 -4.9 0.4 0.3; Scenario 2: -6.3 -6.5 -1.9 -2.1 5.0 4.7. - Cumulative adjustment need (percent of GDP) Scenario 1: -3.3 0.5 3.2 4.2 4.2; Scenario 2: -3.3 4.0 6.0 8.7 8.7. - Note: The fiscal year runs from April 1 to March 31. ### Fiscal space to restore sustainability - Adjustment magnitude and composition: - Total adjustment need around 9 percent of GDP over five years under ambitious scenario. - Tax policy measures already quantified would contribute around 2 percent of GDP to the total adjustment. - Wage bill savings could contribute around 3 percent of GDP. - With recurrent spending close to 38 percent of GDP and severe spending inefficiencies, overall adjustment is demanding but feasible. - Cross-country analysis: - Lesotho has a relatively high tax-to-GDP ratio; low-hanging fruits for adjustment are on the expenditure side (Annex III). - Sizable scope exists for recurrent expenditure cuts; these were main source of adjustment during FY 2010/11 SACU shortfall. - Authorities agree bulk of adjustment must come from expenditure side but recognize political difficulty and consider some tax measures. - Government emphasizes financing needs for infrastructure to improve conditions for private investment; scope for cuts in low-quality, long-dragging projects. ### Possible measures to reduce spending and protect the poor - Emphasis on improving spending efficiency and preserving long-term growth potential while protecting low-income households. - Social protection targeting: - Ongoing work by Ministry of Social Development with UNICEF, the EU, and the World Bank to establish a comprehensive database of low-income households to improve targeting of social safety net. - Completion of household survey currently under preparation would allow Fund staff to conduct detailed fiscal incidence analysis on poverty and inequality to identify adjustment measures least harmful to the poor. *IMF staff summary of Lesotho: context, vulnerabilities, outlook, and fiscal policy options as presented in the source document.* ### 18. Fund staff emphasized the need to continue the efforts to reduce the wage bill ### 18. Fund staff emphasized the need to continue the efforts to reduce the wage bill ### Wage bill reforms and estimated savings - Fund staff recommended continuing efforts to reduce the wage bill initiated in the FY 2017/18 budget; the government has not taken a decision yet. - FAD technical assistance provided cost saving estimates. A combination of measures would bring the wage bill to a more reasonable range over the medium term: - Implementing a temporary hiring freeze for the next two fiscal years would save 0.4 points of GDP. - Limiting the cost of living adjustment to half the rate of inflation between FY2019/20 and FY2022/23 would cut the wage bill by 1.5 points of GDP in five years. - Linking “notch” increases, currently awarded to everyone, to performance, and limiting them to one out of three workers would reduce the wage bill by 1.3 points of GDP by FY2022/23. - Authorities are working to complete an effective establishment list to calibrate employment to government priorities. - Ongoing World Bank biometric audits aim to resolve the ghost worker issue. - Authorities are considering a cost of living adjustment for FY 2018/19 below the inflation rate. ### Sectoral spending inefficiencies and potential cuts - Draft World Bank Public Expenditure Review finds sizable scope to cut spending in health and education due to large inefficiencies. - Education: - The wage bill in education accounts for more than a third of the government’s wage bill due to high teachers’ salaries. - Primary school teachers receive an average wage that is 8 times the per capita GDP in Lesotho, as opposed to just 3 in South Africa. - Starting salaries are 30 percent higher for teachers with a college diploma in education, although the higher salary does not convey higher responsibilities. - Health: - Lesotho has almost doubled its expenditure in health care in the last decade, but health outcomes have not improved. - Identified problems: low quality of services, lack of equipment, lack of skilled staff and commodities, and a weak referral system leading to low and unequal utilization of health facilities. - A recently-announced “test and treat” program aims to address the HIV problem. - Other spending inefficiencies: - The government spends 2 percent of GDP on student loans; means testing and stronger loan recovery could reduce this significantly. - Goods and services have slack, including travel and government car fleet expenses equivalent to 3 percent of GDP. - Travel subsistence accounts for more than 5 percent of goods and services and is very generous with per diems significantly higher than South African public servants’. ### Public Financial Management (PFM) reforms and priorities - Improving PFM is core to improving spending efficiency, reducing financial integrity risks, and facilitating macroeconomic management. - Despite TA by the EU Commission, World Bank, African Development Bank, and IMF, basic systems are still missing (2016 PEFA update). - FAD TA condensed past recommendations into a reform plan with priorities: - Reconcile accounts and improve monitoring of numerous accounts in commercial banks to reduce fraud risk and improve fiscal reporting; moving to a Treasury Single Account would facilitate reconciliation and cash management. - Address persistent IT problems with the CBL’s Core Banking System to facilitate account reconciliation. - Improve commitment control and cash management to ensure timely payments and reduce government arrears’ drag on businesses. - Upgrade the IFMIS system with World Bank support to revamp reporting. - Government has tightened procurement by granting permission to circumvent regular procedures only for exceptional cases stipulated in law. ### Domestic revenue mobilization options and revenue potential - Tax policy discussions focused on widening the tax base: - Government is in the process of approving a levy on tobacco and alcohol products following World Bank recommendations. - IMF staff proposed raising the levy for gasoline from 60 to 200 lisente per liter; little appetite in government. - Aligning the VAT rate for telecoms and electricity to the regular VAT rate of 14 percent is under consideration; concerns about redistributive effects remain. - Introducing a presumptive tax for small-scale/informal businesses is under consideration. - IMF staff urged revisiting tax incentives in law, including a CIT exemption for life insurance; the insurance sector size is equivalent to 1.1 percent of GDP. - Ministry of Trade discretionary CIT holidays to foreign investors have been curtailed by the new government; staff suggested assessing revenues lost from old tax holidays and exploring phase-out options. - Text Table 3. Revenue Potential of Tax Measures (IMF staff estimates): - Introducing levy on alcohol and tobacco: 200 million Maloti, 0.5 percent of GDP - Raising levy on gasoline: 300 million Maloti, 0.8 percent of GDP - Alignining VAT rate for telecoms and electricity: 180 million Maloti, 0.5 percent of GDP - Total: 680 million Maloti, 1.8 percent of GDP - Tax administration reforms and immediate revenue potential: - New LRA Board appointment; progress reconciling tax payments via banking system with taxpayer liabilities to phase out cash payments. - Address CIT shortfalls from large taxpayers through better monitoring of quarterly financial statements and imposing interest charges on delayed payments; for mining, establish automatic data exchange between LRA and Ministry of Mining. - Strengthen risk management and IT (ASYCUDA outages on customs; manual risk management in tax administration) to improve audit effectiveness and compliance. ### Deficit financing, debt space, and external financing - Debt Sustainability Analysis (DSA) indicates a low risk of debt distress, creating scope to ease fiscal adjustment by mobilizing additional external financing with a high grant element. - Government negotiating sizable externally financed infrastructure projects using fiscal space from relatively low, predominantly concessional external debt. - Staff and authorities agreed to preserve a relatively high grant element in external debt portfolios due to narrow export base and South African-related exchange rate risks. - Millennium Challenge Corporation (MCC) re-selection of Lesotho as eligible in December 2017 opens an avenue to significant grant financing. - Domestic debt: - Low domestic debt level indicates fiscal space via additional domestic borrowing, but requires restoration of sustainable fiscal policy and improvements in debt management. - Interest in maloti-denominated assets exists; developing the domestic debt market requires predictable size, terms, timing of bond issuances and a functioning secondary market. - Authorities see scope for larger and more frequent issuances but are cautious given borrowing cost containment. ### Monetary policy measures - Margin for monetary policy is limited under the CMA, but tools to mop up liquidity could mitigate reserve pressures. - Banking system has high liquidity, much held abroad with South African banks. - CBL’s issuance of short-term treasury bills for monetary policy are capped at 700 million maloti and usually oversubscribed. - Staff encouraged raising the ceiling on T-bill issuances to 1 billion maloti to mop up liquidity and induce repatriation of liquid assets; authorities welcomed proposal pending further CBL–Ministry of Finance discussion. - Revision of regulations for liquid asset requirements (LAR) recommended: - Currently CBL allows banks to account gross claims against each other as liquid assets, enabling creation of liquid assets by mutual agreement and rendering LAR constraint meaningless. ### Private sector development, red tape, and sectoral reform priorities - Government focus on private sector development to widen growth beyond capital-intensive projects and strengthen growth-employment nexus; NSDP II under development to reflect priorities. - Red tape reduction: - One-stop shop for business registration being implemented though integration incomplete. - World Bank assistance reduced cost and time for construction permits; risk-based inspection guidelines under development. - Preparations for product standards and market access for local producers are underway. - Mining sector policy cautioned: - Staff warned against duplicative regulatory structures, local participation requirements, and forced domestic processing/beneficiation that could deter investment. - Recommended focus on a fiscal regime (rent tax aligned with international best practice) to capture economic rents rather than government equity participation. - Sectoral priorities for NSDP II: tourism, technology and innovation, agriculture, manufacturing. - Fund team advised evaluating existing programs before new costly programs; reforms vulnerable to corruption concerns. - Lesotho National Development Corporation restructuring under World Bank review recommendations; comprehensive review of existing instruments suggested. - Long-term: better education and health spending efficiency essential to raise labor productivity and reduce inequality. - Manufacturing wages in Lesotho anecdotal range: from a fifth to a third of South African workers’ wages. ### Strengthening financial sector contribution to growth - Bank resilience: - CBL stress testing using end-2016 data: 30 percent of the system’s performing loan portfolio would have to become non-performing to breach the minimum capital adequacy ratio of 8 percent, compared to 1.6 percent NPL as of the second quarter of 2017. - Even if all highly indebted civil servants defaulted, additional NPLs would account for less than 10 percent of the loan portfolio. - Household indebtedness: - Authorities applied a 70 cap on payroll deductions to address high indebtedness of civil servants collateralized through the payroll withdrawal system; staff asked to explore options to gradually reduce this cap to phase out the payroll deduction system. - Newly established credit bureau offers alternative risk reduction for lenders to reduce reliance on payroll deductions. - Financial intermediation constraints: - Banks’ strong preference for highly liquid assets dampens intermediation and contribution to growth; reasons include business environment constraints and need to maintain convertibility of loti deposits into Rand. - Prudent fiscal policy that preserves high international reserves would support conditions for financial intermediation. - Mobile money and financial inclusion: - Fast-growing mobile money services are major drivers of improving financial access; CBL regulates lightly to foster reach and reduce costs while monitoring risks. - Banks and Post Bank plan mobile solutions; Post Bank expects to launch an application for micro savings and borrowing. - Mobile wallets can reduce fees for low-income households, but the current cap on mobile payments in Lesotho is low: - Text Table 4. Daily Cap on Mobile Payments (in USD): Lesotho 195 (note: cap in Lesotho is 2,500 maloti daily and 10,500 maloti weekly). - Comparative caps: Tanzania 1,775; Uganda 1,300; Kenya 1,250; Ghana 300; Nigeria 300. *Source: cr1854 - 18. Fund staff emphasized the need to continue the efforts to reduce the wage bill* ### 35. The government is discussing options to make the state-owned Post Bank a more ### 35. The government is discussing options to make the state-owned Post Bank a more ### Post Bank role and financial inclusion - With the financial situation of the Post Bank improving, Fund staff agreed that there is scope to strengthen its role of facilitating access to financing for small businesses, but emphasized that sound banking principles need to be respected. - Plans to cooperate with mobile operators to offer affordable banking services are well placed to promote financial inclusion in an environment of very high banking fees. - If the government considers an explicit development mandate for the Post Bank, government-funded credit lines and/or capital would be needed to protect private deposits. ### Supervision architecture for non-banks - A new supervision architecture for non-banks is a major step forward but implementation has been slow due to delays in the legislative approval, and challenges remain in enforcing the new framework. - Status of supervisory responsibilities: - The new Pensions Bill still remains to be approved by parliament. - The CBL has now wide-ranging supervision authority for the insurance sector. - The Ministry of Small Businesses, Cooperatives and Marketing will remain responsible for the supervision of financial cooperatives, except for large ones which are to be supervised by the CBL. - The Ministry is in the process of closing crucial data gaps and improving stability and efficiency through mergers. - Staff concern: a large deposit-taking cooperative, which is highly relevant in providing access to financial services, has so far refused to comply with the requirements of the new supervision architecture and remains insufficiently supervised. ### Data quality and other surveillance issues - While data quality is broadly adequate for surveillance purposes, urgent work must be done to improve data transparency and reliability. - MCM TA identified problems with the Core Banking System and gaps in the CBL’s domestic debt data, including internal and publicly-available government securities data. - Implementation of STA TA on national accounts and price data has been slow and data gaps like employment data remain unaddressed, hampering policy formulation. - Legal requirements in the IMF’s Article of Agreement to compile general government data cannot currently be met in view of limited capacity. ### Fiscal outlook and policy priorities - After two years of expansionary fiscal policy that has almost depleted fiscal buffers, the pressure to restore fiscal sustainability is rising, which is very challenging in the fragile political environment. - Restoring fiscal and, consequently, external stability requires decisive fiscal adjustment. - Further delaying these decisions would put at risk economic stability that has been anchored for decades in the CMA; instability and widespread arrears accumulation would derail the development agenda. - Fiscal adjustment recommendations: - Prioritize expenditure measures, especially by addressing severe spending inefficiencies, complemented by measures to improve domestic resource mobilization, while seeking to protect the poor. - Address the high wage bill to achieve necessary adjustment now and to make public finances more flexible in future cyclical swings. - PFM reform to address spending inefficiency is a precondition to improve the quality of health and education services and reduce inequality. - Selective revenue measures aimed at broadening the tax base and improving tax administration efficiency should complement the reform package. ### External financing and reserves - The DSA findings underline some scope to increase external financing until the projected cyclical upswing eases fiscal pressures over the medium term. - Opportunities: advance high quality infrastructure projects financed by development partners with a significant grant element to ease the negative impact of fiscal consolidation. - External financing at commercial terms to finance the deficit is strongly discouraged as it would add a source of future vulnerability. - The CBL can reduce some of the pressure on reserves. Increasing the cap on treasury bill issuances has some potential to ease pressure on reserves in combination with improving the LAR. ### Private sector and financial sector development - Developing the private sector is critical to create broad-based growth and ease the impact of fiscal adjustment on the economy. - Authorities are promoting labor-intensive industries; this should be complemented by measures to reduce red-tape and a comprehensive evaluation of existing private sector development programs. - Over the long term, improving the quality of health and education spending will support human capital development and reduce inequality. - Strengthening the financial sector’s contribution to growth: - Banks in Lesotho are well-positioned to absorb a negative shock. - Staff welcomes the newly established credit bureau and a cap on payroll deductions as important steps in tackling household indebtedness. - Improved macroeconomic management, more widespread use of mobile money, and an increased role for the Post Bank will support efforts to improve the relatively low level of private sector credit. - The new supervisory architecture for the non-bank financial sector has the potential to strengthen stability and improve the contribution to financial inclusion. *KINGDOM OF LESOTHO INTERNATIONAL MONETARY FUND STAFF APPRAISAL* ### 44. Staff recommends that the next Article IV consultation for Lesotho be held on the ### 44. Staff recommends that the next Article IV consultation for Lesotho be held on the standard 12-month cycle. ### Social indicators: growth, poverty, health, and education - Lesotho "has grown strongly over the past decade... but with little effect on unemployment." - Poverty and inequality: - Poverty rate (percent, 2011 est.): 57 - Inequality: "among the highest in the world" (Figure shows Lesotho among countries with highest Gini). - HIV/AIDS prevalence: - "Prevalence of HIV, Total (percent of population ages 15-49)" — Lesotho much higher than SSA (chart). - Education: - "Literacy Rates (percent of population aged 15+)" and youth/adult literacy series shown (2000–2014) indicate stagnation or worsening. ### Recent economic developments - Growth and external exposure: - "Growth in Lesotho has been affected by South Africa’s slowdown... which has translated into lower SACU revenues." - Inflation and interest rates: - Consumer prices (average): 2014/15: 5.0; 2015/16: 4.6; 2016/17: 4.3; 2017/18: 6.2; 2018/19 projection: 5.6; 2019/20: 5.5; 2020/21: 5.0; 2021/22: 5.0; 2022/23: 5.0. - Consumer prices (eop): 2014/15: 5.5; 2015/16: 2.0; 2016/17: 7.5; 2017/18: 4.4; 2018/19: 6.0; subsequent projections 5.5–5.0. - "Interest rates are mainly driven by rates in South Africa" (T-bill charts shown). - GDP: - Real GDP growth (percent): 2014/15: 2.2; 2015/16: 3.0; 2016/17: 2.5; 2017/18: 3.1; 2018/19 projection: 3.1; 2019/20: 1.7; 2020/21: 2.6; 2021/22: 2.1; 2022/23: 2.9; 2023/24 projection: 3.5 (Table 1 series). - GDP at market prices (millions Maloti): 2016/17: 32,405; 2017/18: 34,325; 2018/19: 37,687; 2019/20: 40,591; 2020/21: 43,929; 2021/22: 47,218; 2022/23: 50,923; 2023/24: 55,240. ### External vulnerabilities - Current account and reserves: - Current account balance (Including official transfers, percent of GDP): 2013/14: -5.5; 2014/15: -4.9; 2015/16: -4.5; 2016/17: -7.4; 2017/18: -6.5; 2018/19: -11.3; 2019/20: -11.6; 2020/21: -4.4; 2021/22: -7.0; 2022/23: -11.2 (Table 1). - Current account (exc. LHWP-2 project, percent of GDP): 2013/14: -5.5; 2014/15: -4.9; 2015/16: -4.5; 2016/17: -7.4; 2017/18: -5.5; 2018/19: -6.3; 2019/20: -6.8; 2020/21: -2.9; 2021/22: -2.3; 2022/23: -1.8. - Gross international reserves (Months of imports, excluding imports for LHWP-2): 2013/14: 5.2; 2014/15: 5.5; 2015/16: 6.1; 2016/17: 4.2; 2017/18: 3.6; 2018/19: 3.1; 2019/20: 2.5; 2020/21: 2.2; 2021/22: 1.9; 2022/23: 1.8. - Gross international reserves (US$ millions): 2013/14: 976; 2014/15: 1,029; 2015/16: 949; 2016/17: 825; 2017/18: 745; 2018/19: 683; 2019/20: 616; 2020/21: 581; 2021/22: 557; 2022/23: 576. - Trade and FDI: - Imports and exports of goods and services remain high relative to GDP; imports structurally high. - "FDI inflows declining as major mining projects are completed." ### Fiscal imbalances and structure - Fiscal dependence on SACU revenues: - SACU revenue (percent of GDP): 2014/15: 23.9; 2015/16: 24.0; 2016/17: 19.7; 2017/18: 13.2; 2018/19: 16.3; 2019/20: 13.6; 2020/21: 11.4; 2021/22: 15.7; 2022/23: 15.6; 2023/24: 15.5 (Table 3). - Revenue and expenditure: - Revenue and grants (percent of GDP): 2014/15: 52.3; 2015/16: 49.8; 2016/17: 47.2; 2017/18: 40.9; 2018/19: 39.8; 2019/20: 37.8; 2020/21: 37.0; 2021/22: 41.4; 2022/23: 41.4; 2023/24: 41.2. - Expenditure (percent of GDP): 2014/15: 41.0; 2015/16: 39.5; 2016/17: 37.1; 2017/18: 37.6; 2018/19: 37.8; 2019/20: 35.0; 2020/21: 34.1; 2021/22: 33.6; 2022/23: 33.2; 2023/24: 32.7. - Overall balance (percent of GDP): 2014/15: -1.7; 2015/16: 0.3; 2016/17: -1.0; 2017/18: -6.3; 2018/19: -6.5; 2019/20: -5.3; 2020/21: -4.9; 2021/22: 0.4; 2022/23: 0.3; 2023/24: 0.4. - Wage bill and social spending: - Compensation of employees (percent of GDP): 2014/15: 18.1; 2015/16: 17.0; 2016/17: 17.1; 2017/18: 17.8; 2018/19: 17.4; 2019/20: 16.5; 2020/21: 16.4; 2021/22: 16.1; 2022/23: 16.1; 2023/24: 16.0. - "One of the largest wage bills in the world... and high and inefficient social spending." ### Monetary and financial developments - Credit and banking: - Banks' credit to the private sector, 2016 (percent of GDP): Lesotho among lowest in region (chart shows Lesotho < 30 percent; Table 4 indicates credit to private sector percent of GDP: 2013/14: 10.3; 2014/15: 11.8; 2015/16: 8.2; 2016/17: 5.8; 2017/18: 8.5; 2018/19: 16.4; 2019/20: 0.5). - "Credit to the private sector has decelerated... and remains very low compared to the region." - Loan-deposit spreads and banking profitability remain high; "a very profitable banking sector... which is stable and well-capitalized... but has failed to foster formal financial inclusion." - Monetary aggregates and reserves: - Broad money (M2, Maloti millions): 2013/14: 9,105; 2014/15: 9,240; 2015/16: 9,829; 2016/17: 10,692; 2017/18: 11,756; 2018/19: 12,846; 2019/20: 13,075. - Reserve money (Maloti millions): 2013/14: 1,385; 2014/15: 1,499; 2015/16: 1,839; 2016/17: 1,896; 2017/18: 2,401; 2018/19: 2,024; 2019/20: 1,363. - Gross international reserves to M1 (percent): 2013/14: 248; 2014/15: 294; 2015/16: 284; 2016/17: 208; 2017/18: 169; 2018/19: 136; 2019/20: 114; 2020/21: 102; 2021/22: 91; 2022/23: 88. ### Projections and macro framework (Scenario 1 highlights) - GDP growth projections (percent): 2018/19: 3.1; 2019/20: 1.7; 2020/21: 2.6; 2021/22: 2.1; 2022/23: 2.9; 2023/24: 3.5. - Public debt (percent of GDP): - Public debt: 2014/15: 37.4; 2015/16: 36.9; 2016/17: 41.3; 2017/18: 35.4; 2018/19: 35.4; 2019/20: 38.8; 2020/21: 43.2; 2021/22: 45.3; 2022/23: 47.0; 2023/24: 47.7. - External public debt (percent of GDP): 2014/15: 34.5; 2015/16: 34.3; 2016/17: 38.3; 2017/18: 32.3; 2018/19: 31.4; 2019/20: 33.3; 2020/21: 34.9; 2021/22: 35.9; 2022/23: 36.3; 2023/24: 36.5. - Fiscal projections (percent of GDP): - Revenue and grants: projected near 41.4–41.2 in 2021/22–2023/24. - Overall balance improves to small surpluses in projection years: 2021/22: 0.4; 2022/23: 0.3; 2023/24: 0.4. ### Balance of payments and external financing (selected figures) - Current account (US$ millions): 2013/14: -138; 2014/15: -131; 2015/16: -105; 2016/17: -182; 2017/18: -181; 2018/19: -333; 2019/20: -359; 2020/21: -140; 2021/22: -233; 2022/23: -390 (Table 5). - Trade balance (US$ millions): 2013/14: -975; 2014/15: -954; 2015/16: -759; 2016/17: -725; 2017/18: -867; 2018/19: -936; 2019/20: -924; 2020/21: -900; 2021/22: -984; 2022/23: -1,110. - Official transfers (US$ millions): 2013/14: 667; 2014/15: 679; 2015/16: 498; 2016/17: 352; 2017/18: 513; 2018/19: 457; 2019/20: 410; 2020/21: 564; 2021/22: 581; 2022/23: 600. ### Banking sector performance (2009–17 highlights) - Basel capital ratio (end-period, percent): ranges from 12.6 to 18.0 across 2009–2017; Q2 2017: 17.2. - Return on assets (ROA, percent): 2009: 2.8; 2010: 2.7; 2011: 2.8; 2012: 3.0; 2013: 4.9; 2014: 4.5; 2015: 4.5; Q1 2017: 1.1; Q2 2017: 4.1. - Nonperforming loans to total assets (percent): 2009: 3.2; 2010: 3.1; 2011: 2.2; 2012: 2.5; 2013: 3.7; 2014: 4.1; 2015: 3.9; Q1 2017: 1.7; Q2 2017: 1.6. - Cost to income and interest margins indicate relatively high profitability but mixed efficiency (tables and ratios provided). *Source: Lesotho authorities, World Bank, and IMF staff estimates and projections (figures, tables, and charts as presented).* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Global Risks - Tighter and more volatile global financial conditions, associated with sharp rise in risk premia, or further unanticipated tightening of U.S. monetary policy. - Relative Likelihood: Medium - Expected impact on the economy if risk is realized: - Lesotho has no access to international capital markets; spillovers would be strong due to dependence on South Africa (SA). - Rising capital costs would weigh negatively on the economic outlook for SA, leading to a slowdown in activity in Lesotho and weaker SACU transfers. - Stronger U.S. dollar could increase the import bill for Lesotho, leading to further deterioration of the current account. - Relative Impact: Low - Possible remedial policy: Advance structural reforms to increase competitiveness and diversification, and reduce income inequality to develop domestic markets. - Weaker-than-expected global growth, including significant slowdown in China, large EMS, or key advanced and emerging economies. - Relative Likelihood: Medium - Expected impact on the economy if risk is realized: - Depressed global demand translates into weaker Lesotho exports to the rest of the world, in particular to the main trading partner, SA, and to a lesser extent, the U.S. and EU. - An economic slowdown in SA would reduce SACU transfers, which form a substantial portion of fiscal revenues. - Relative Impact: Medium - Possible remedial policy: Advance structural reforms to increase competitiveness and diversification, and reduce income inequality. ### Domestic Risks - Continued political instability. - Relative Likelihood: High - Expected impact on the economy if risk is realized: - Political instability would delay reform implementation, particularly for the urgently-needed fiscal consolidation efforts. - Failure to address the SADC recommendations may also jeopardize AGOA access. - Relative Impact: High - Possible remedial policy: Produce the roadmap for SADC recommendations by the end-November deadline, and implement the reforms accordingly. - Insufficient fiscal adjustment to sharp decline in SACU transfers. - Relative Likelihood: High - Expected impact on the economy if risk is realized: - Lesotho’s fiscal and external position would decline sharply with negative repercussions for the stability of the peg to the Rand. - Relative Impact: High - Possible remedial policy: Implement fiscal consolidation and seek concessional financing by reengaging with donors. *Source: Annex I. Risk Assessment Matrix (cr1854 - Annex I. Risk Assessment Matrix)* --- ### Annex II. Lesotho’s Large Wage Bill ### Key findings - The government wage bill in Lesotho is one of the highest in the world at 18 percent of GDP. - Public sector wages are very high though public employment is not disproportionate. - The average wage in the public sector is 13.6 times GDP per capita compared to only 4.1 in South Africa. - With respect to GDP per capita, wages in Lesotho are higher than in South Africa for all grades in the civil service pay scale, largest for the highest grades. - Real wages to middle and high grades are competitive with South African levels after adjusting for purchasing power differences. - Wage dynamics: - Wages in the public sector grew faster than inflation in eight of the last ten years. - Generous cost of living adjustments and “notch” increases shift workers automatically to the next higher point-value of their grade regardless of performance. - Employment composition: - Almost a third of the employees are in the bottom two grades. - Management perception in some ministries is overemployment in bottom two grades and underemployment in middle grades. - Implementation of an effective establishment list is critical to assess real manpower needs. - Public-private wage comparisons: - Public employees receive 43 percent higher wages than comparable workers in the private sector (estimate using the Continuous Multipurpose Survey of 2013/14 controlling for education, age, and gender). - After the 2013/14 pay structure review: - Public employees with tertiary education are paid 60 percent more than their peers in the private sector (whereas the difference was insignificant in FY2010/11). - Public-sector premium remains minimal for employees with a primary education and around 40 percent for employees with a secondary education. *Source: Annex II. Lesotho’s Large Wage Bill (cr1854 - Annex I. Risk Assessment Matrix)* --- ### Annex III. Restoring Fiscal Space ### Revenue mobilization - Lesotho collects relatively more than comparable countries in income and consumption taxes, indicating narrow scope for further revenue measures. - Tax potential analysis using fixed-effects panel and stochastic frontier regressions shows Lesotho mobilizes more domestic taxes than comparable countries in the region. - Performance is particularly strong for income taxes, possibly explained by the relatively high tax rate. ### Spending efficiency - Lesotho spends large amounts on social sectors, but spending is inefficient. - Health: spending over 8 percent of GDP in health care, but outcomes are extremely weak (low life expectancy, high prevalence of HIV/AIDS and tuberculosis, and high and rising infant and maternal mortality rates). - Education: receives about 13.2 percent of GDP in funding in recent years while outcomes have remained stagnant or deteriorated. - Countries along the “best practice frontier” in the region show better outcomes with even lower spending levels. *Source: Annex III. Restoring Fiscal Space (cr1854 - Annex I. Risk Assessment Matrix)* --- ### Annex IV. External Sector Assessment ### Recent developments - The external position weakened in 2016/17 because of a decline in SACU revenues and lower exports, but remained broadly in line with medium-term fundamentals and desirable policies. - The current account deficit deteriorated in 2016/17 due to: - A steep drop in SACU transfers of about 7 percent of GDP. - Lower diamonds exports. - SACU transfers: - Dropped by almost half in FY 2016/17 compared to the peak of 24 percent of GDP in FY2014/15. - Lesotho’s imports represent about 90 percent of GDP and their financing is highly dependent on SACU transfers. - SACU transfers are highly correlated with South African imports; they will decline further in FY 2018/19 and are expected to bottom out only in FY 2019/20. - Over the medium term, SACU transfers are projected to recover in line with the cyclical upswing in South Africa. - Projects and exports: - The Lesotho Highlands Water Project Phase II will generate large capital grants in the near term; imports of capital goods will partly offset these grants, and over the long term the project will contribute to exports. - Export concentration risk: over 25 percent of exports (mainly textiles) directed to the United States, exposing the country to volatility in the Rand/dollar exchange rate. ### Financing and reserves outlook - FDI inflows reached about 4 percent of GDP in 2014/15 and 2015/16, partly reflecting investments in diamond mining. - Moving forward, international reserves in months of prospective imports are projected to decline as there are no offsetting factors to the sharp drop in SACU revenues. ### Exchange rate assessment and competitiveness - The EBA-lite current account approach: - Current account norm: 6.6 percent of GDP. - FY 2016/17 current account deficit: 7.4 percent of GDP. - Conclusion: exchange rate broadly in line with fundamentals. - Real effective exchange rate developments are driven by factors originating in South Africa and broadly mirror nominal exchange rate movements; depreciation trend from 2011 to 2016 has been partly offset by a recent Rand appreciation. - Considering SACU transfers and the currency peg, the Loti appears to be broadly in line with current fundamentals. - Competitiveness indicators: - Lesotho among the worst ranked SACU members in both the 2017 Ease of Doing Business and the 2016-17 Global Competitiveness Report overall rankings. - Major problematic factors for doing business in Lesotho: Access to financing (most problematic), followed by corruption and inadequate supply of infrastructure. *Source: Annex IV. External Sector Assessment (cr1854 - Annex I. Risk Assessment Matrix)* --- ### Annex V. Reserve Adequacy ### Recent reserve trends and metrics - Lesotho’s international reserves: - Peak at US$1.1 billion in August 2014. - Reserves at end-August 2017: US$864 million, equivalent to around four months of prospective imports. - Optimal level of reserves is estimated at around 4.7 months of imports. - Traditional metrics: reserves remained above minimum thresholds: - 3 months of imports, - 100 percent of short-term debt, - 20 percent of broad money. - Reserves cover 185 percent of short-term debt and more than 100 percent of broad money. ### Optimal reserves and rationale - A cost-benefit panel model regression adapted for credit-constrained economies estimates an optimal level of reserves of 4.7 months of imports, assuming a cost of holding reserves of about 3.5 percent. - Emphasis on heightened level of reserves for Lesotho given: - Fixed exchange rate regime. - Need to build resilience against external shocks. - Trending decline in SACU transfers and uncertainties surrounding other foreign exchange receipts. - Imports from South Africa account for more than 80 percent of Lesotho’s imports; CBL keeps a significant share of foreign reserves as South African Rand. *Source: Annex V. Reserve Adequacy (cr1854 - Annex I. Risk Assessment Matrix)* --- ### Annex VI. Debt Sustainability Analysis ### Risk classification and drivers - Lesotho’s risk of external debt distress revised from “moderate” in the 2015 Article IV to “low” in 2017, mainly due to: - Recent rebasing of GDP. - Solid GDP growth. - Revisions to the assessment for new borrowing requirements (tied to non-inclusion of a hydropower project in the current analysis). - Under the baseline scenario, all indicators remain below corresponding thresholds throughout the projection period. - Present value of external public and publicly guaranteed (PPG) debt-to-GDP ratio reaches a peak of around 24 percent by 2020, well below its threshold of 40 percent of GDP. ### Stress tests and policy implications - Under stress tests, a large negative shock to exports is the main risk for possible deterioration of external debt indicators. - Even under the most extreme simulated shocks, debt ratios remain below corresponding thresholds. - Implication: Lesotho has some scope to address challenges from the severe cyclical downswing of SACU revenues by new external borrowing. - However, sensitivity to export shocks illustrates the need for a sizable grant component in new external debt as part of a prudent debt strategy to preserve the low risk of debt distress. ### Domestic debt and contingent liabilities - Domestic debt is low at around 3 percent of GDP in 2016. - Additional domestic contingent liabilities from the underfunded pension system add about 3.5 percentage points of GDP in present value terms. - Recent debt dynamics: - Total public debt declined from 41.3 percent of GDP in 2015 to 35.4 percent in 2016. - Drivers: decline in valuation of foreign-exchange denominated external debt due to a 10 percent Rand appreciation, limited new borrowing, and solid GDP growth. - External debt represented 88.7 percent of total debt, with a substantial share contracted with multilateral creditors. - Policy actions: - Government initiated work with World Bank assistance to address pension fund liabilities. - Technical assistance provided in 2017 to assist government in developing a medium-term debt strategy. *Source: Annex VI. Debt Sustainability Analysis (cr1854 - Annex I. Risk Assessment Matrix)* *Source: cr1854 - Annex I. Risk Assessment Matrix (PDF chapter/section)* ### 2. The previous DSA (2015) assessed Lesotho’s risk of external debt distress as ### 2. The previous DSA (2015) assessed Lesotho’s risk of external debt distress as ### Background and context - The 2015 DSA rated Lesotho’s risk of external debt distress as moderate. - The moderate rating was driven by including financing assumptions for a potential hydropower project that could be added to the second phase of the Lesotho Highlands Water Project (LHWP-II). - LHWP II is grant funded, but the hydropower project would probably be financed mostly on commercial terms; these borrowing assumptions pushed the PV of PPG external debt-to-GDP in the 2015 DSA close to the 40 percent threshold by 2025. - The hydropower project proved more complex than expected; new feasibility studies were initiated with very different cost and economic implications. With discussions at an early stage, the project is not included in the macroeconomic baseline projections for the 2017 DSA. ### Macroeconomic, fiscal, and financing assumptions (as used in the 2017 DSA) - Macroeconomic assumptions: - Real GDP growth projected to reach 3.1 percent in 2017/18, ease to 1.7 percent in 2018/19, and over the long term conservatively projected to average about 3½ percent a year. - By 2025, when LHWP II is finalized, the current account deficit is expected to narrow gradually. - Annual CPI inflation expected to remain broadly unchanged at 5.5 percent until 2019/20 and to remain around 5 percent in the medium term. - Exports expected to be mainly driven by diamonds, textiles, and water. - Fiscal assumptions: - Fiscal year 2016/17 ended with a deficit of 6.3 percent of GDP. - FY 2017/18 deficit expected to reach about 6.5 percent of GDP due to domestic revenue shortfalls despite a moderate rise in SACU revenues. - Cyclical upswing in SACU revenues expected by FY 2020/21, leading to broadly balanced budgets thereafter. - Financing assumptions: - Borrowing plan assumes a need for highly concessional external financing with a large grant element continuing in the medium term. - 75 percent of total outstanding debt owed to multilateral creditors carrying a large concessional component. - The 2017 DSA assumes the grant element in new borrowing is expected to remain high. - Government planning to borrow on average US$45 to 50 million per year to finance new projects in the medium term. - New financing mix: foreign development assistance and partly concessional loans (IDA, African Development Bank, EU, Saudi Fund, Abu Dhabi, BADEA and China). - Lesotho’s eligibility for the Millennium Challenge Corporation (approved in December 2017) should open up access to significant grant financing. ### Public outstanding debt (As of end-March, 2017) - Domestic debt: 100 US$ million; Percent of total 11.3 - External debt: 788 US$ million; Percent of total 88.7 - Multilateral: 662 US$ million; 74.6 percent of total - IDA: 282 US$ million; 31.7 - ADF: 122 US$ million; 13.8 - EIB: 116 US$ million; 13.1 - IMF: 65 US$ million; 7.3 - BADEA: 32 US$ million; 3.6 - IFAD: 30 US$ million; 3.4 - OFID: 15 US$ million; 1.7 - Bilateral: 120 US$ million; 13.5 percent of total - China Exim Bank: 50 US$ million; 5.6 - Kuwait Fund: 27 US$ million; 3.1 - Saudi Fund: 23 US$ million; 2.6 - Abu Dhabi Fund: 15 US$ million; 1.6 - India Exim Bank: 6 US$ million; 0.6 - Commercial: 60 US$ million; 6.0 - Total: 888 US$ million; 100.0 percent of total ### Baseline external debt sustainability findings - All external debt sustainability indicators remain below their corresponding thresholds in the baseline scenario. - The present value (PV) of PPG external debt-to-GDP is expected to reach a maximum of 23.6 percent by 2020. - The debt path is supported by an assumed large grant element in new borrowing (42 percent) in line with past borrowing practices. - New financing targets projects including airport expansion, roads (Mpiti-Sehlabathebe), water supply (Lowlands Water Project), tax modernization, and other infrastructure projects (Mesitsaneng-Ha TSepo). - The LHWP II, once finalized by the end of the medium term, will increase exports. ### Sensitivity analysis and stress tests - Export shock (terms-of-trade shock): if export values grow at one standard deviation lower than the historical average, the PV of debt-to-GDP would likely be brought close to the 40 percent threshold in 2020 and remain near the threshold for a few years. - PV of external debt-to-export ratio would peak at 120.2 percent by 2019 in this scenario. - Historical-average scenario: setting key variables at their average of the past 10 years causes external debt ratios to fall relative to the baseline, reflecting an average fiscal surplus from large SACU revenues, strong GDP growth, and inflation averaging about 5 percent; but structural breaks and cyclical SACU revenue weakness make the historical scenario less relevant. - Concessionality of new borrowing: - If new borrowing is transacted at similar terms to the current portfolio (high grant), outcomes remain favorable. - If current portfolio is replaced by new borrowing at market terms, the PV of debt-to-GDP would reach a maximum of 32 percent, still below the threshold; however, under an export shock the threshold would be breached. - The DSA highlights urgency for a medium-term debt strategy to define appropriate financing mix. ### Public sector debt dynamics and vulnerabilities - Domestic debt is relatively small; total public sector debt trajectory largely determined by external debt developments. - Domestic debt projected to remain at 4 to 5 percent of GDP throughout the projected period unless contingent liabilities from the pension fund materialize. - PV of public sector debt stood at 24.6 percent of GDP in 2016. - Standard sensitivity tests show higher vulnerability to a real depreciation of the exchange rate, pushing the ratio upward but below its benchmark for the forecast period. - Inclusion of contingent liabilities from unfunded pension funds (about 3.5 percent in present value terms) would increase public debt ratios but they would remain below the indicative benchmark. - Weak monitoring of state-owned enterprises limits information about possible domestic contingent liabilities; based on World Bank analysis, the range of possible contingent liabilities would not have a major impact on the DSA. - Fixed primary balance simulation (deficit kept at 5.7 percent of GDP for the whole forecast period) leads to a sharp increase in public debt driven by large cyclical upswing in the primary fiscal deficit estimated for 2017. ### Conclusion and policy recommendations - Lesotho’s risk of debt distress was revised from moderate to low in 2017. - All external debt and debt service indicators for the baseline and simulated shocks remain below their respective thresholds. - A large shock to exports would pose the larger risk to debt sustainability, but even the most extreme shocks do not bring debt ratios above the threshold in the simulations. - Policy implications and recommendations: - Some—though limited—scope exists for additional non-concessional borrowing to finance large infrastructure projects with large economic returns. - Careful cost-benefit analysis and debt sustainability implications must be considered in future government investment plans, including the large hydropower project for which feasibility studies are under way. - Maintaining the significant grant element in financing will avoid risks for future fiscal deficits and international reserves. - The sensitivity to financing assumptions underlines the need for the government to prepare a medium-term debt strategy that defines the appropriate financing mix. *Source: IMF staff analysis in the 2017 DSA (excerpt provided).* ### 12. Authorities concurred with the DSA analysis and the “low” risk rating. They agreed with ### 12. Authorities concurred with the DSA analysis and the “low” risk rating. They agreed with ### Authorities' assessment and recommendations - Authorities concurred with the DSA analysis and the “low” risk rating. - Agreed need to better monitor domestic contingent liabilities to have a comprehensive view of the debt. - Agreed that prudent debt management must continue in the medium term, in particular by pursuing financing with a significant grant element. ### Debt dynamics and projections (selected indicators, 2014–37) - External debt (nominal): 34.3, 38.3, 32.3, 31.4, 33.3, 34.9, 35.9, 35.7, 35.5, 34.5, 32.7, 25.2, 30.3 (percent of GDP) across historical and projection years as shown in Table 1. - PV of external debt (selected entries): ...21.8, 21.3, 22.3, 23.0, 23.6, 23.3, 23.1 (percent of GDP). - PV of PPG external debt (percent of exports): ......54.7, 52.9, 54.3, 55.2, 55.5, 54.7, 54.0; projection: 41.1, 32.0. - PPG debt service-to-revenue ratio (in percent): 2.9, 4.2, 5.1, 3.2, 7.8, 8.1, 6.7, 5.8, 5.6, 5.6, 5.4. - Total gross financing need (Millions of U.S. dollars): 268.8, 240.6, 291.3, 256.4, 459.6, 493.6, 274.2, 371.2, 545.7, 213.6, 185.8. ### Key macroeconomic and fiscal assumptions (selected) - Real GDP growth (in percent): 3.0, 2.5, 3.1, 4.1, 1.7, 3.1, 1.7, 2.6, 2.1, 4.4, 4.7, 3.1, 3.5, 3.5, 3.4. - GDP deflator in US dollar terms (change in percent): 2.6, -13.3, 0.8, -0.7, 10.6, 10.0, 4.4, 2.4, 1.8, 1.1, 0.8, 3.4, 2.0, 2.0, 2.1. - Effective interest rate (percent) 5/: 1.4, 1.7, 1.7, 1.4, 0.2, 1.7, 1.7, 1.5, 1.5, 1.4, 1.5, 1.1, 0.8, 1.0. - Grant element of new public sector borrowing (in percent): 42.3 repeated across projections. - Grant-equivalent financing (in percent of GDP): .........3.1, 4.1, 4.0, 3.6, 3.2, 3.1, 2.6, 2.7, 2.7. - Government revenues (excluding grants, in percent of GDP): 48.1, 44.2, 38.4, 37.7, 35.8, 35.0, 39.6, 39.3, 38.9, 38.1, 38.1, 38.1. ### Aid and financing flows (selected) - Aid flows (in Millions of US dollars) 7/: 123.8, 78.8, 73.3, 84.4, 35.0, 45.6, 41.6, 46.5, 57.7, 53.3, 43.3. - Of which: Grants (Millions of US dollars): 44.8, 70.1, 61.6, 58.3, 60.3, 61.6, 62.6, 63.3, 63.9, 83.7, 144.0. - Of which: Concessional loans (Millions of US dollars): 79.0, 8.7, 11.7, 26.1, -25.4, -16.0, -21.0, -16.7, -6.2, -30.4, -100.7. ### Sensitivity and stress tests (high-level) - Figure 1 and Figure 2 identify the most extreme stress tests (the test that yields the highest ratio on or before 2027); in figures b, c, d, e, and f it corresponds to an exports shock. - Table 2: Sensitivity analysis for key indicators of PPG external debt, 2017–37, includes: - Alternative scenarios: A1. Key variables at their historical averages in 2017-2037; A2. New public sector loans on less favorable terms in 2017-2037 (assumes interest rate on new borrowing is 2 percentage points higher than baseline). - Bound tests B1–B6 covering shocks to real GDP growth, export value growth, US dollar GDP deflator, net non-debt creating flows, combinations of shocks, and one-time 30 percent nominal depreciation in 2018. - Table 4: Sensitivity analysis for public debt indicators, 2017–37, includes scenarios: - A1. Real GDP growth and primary balance at historical averages. - A2. Primary balance unchanged from 2017. - A3. Permanently lower GDP growth. - Bound tests B1–B5 including one-time 30 percent real depreciation and a 10 percent of GDP increase in other debt-creating flows. ### Key numerical benchmarks and indicators (selected memoranda) - Nominal GDP (Millions of US dollars): 2646.6; series: 2350.9, 2442.0, 2768.1, 2937.6, 3083.9, 3205.3, 3381.8, 3571.0, 3158.0, 4682.7, 8051.9, 5661.8 (as presented). - PV of PPG external debt (in Millions of US dollars): 563.7, 597.3, 657.9, 712.0, 755.7, 790.0, 825.6, 1041.6, 1394.0. - Gross workers' remittances (Millions of US dollars): 183.3, 155.4, 153.2, 166.8, 242.1, 270.9, 251.3, 296.4, 299.5, 412.7, 784.0. ### Policy implications emphasized by authorities (from text) - Improve monitoring of domestic contingent liabilities to ensure a comprehensive view of public debt. - Maintain prudent debt management in the medium term. - Pursue financing with a significant grant element. *Source: cr1854 - 12. Authorities concurred with the DSA analysis and the “low” risk rating.* ### Annex VII. Growth in Lesotho: Strong, Narrow, ### Annex VII. Growth in Lesotho: Strong, Narrow, Volatile, and Unequal ### Growth performance and sector contributions - Since 2007, Lesotho averaged real growth of 4.2 percent. - Real per capita GDP grew by more than 50 percent since 2007, substantially faster than the SSA region. - Growth has been narrow and volatile, driven by: - Public sector activity (financed by SACU transfers, diamond mining, and large capital projects). - Diamond mining and large capital projects—including mining and quarrying which contributed to fast growth in the late 2000s but also explained slowdowns in FY09/10 and FY13/14. - Manufacturing (textile) performance has been weak: - Value added by textile manufacturing has declined by almost 7 points as a fraction of GDP since the 2004 peak, despite a recent recovery. - Lesotho benefited from preferential access to US markets via AGOA but failed to upgrade its position in the textile value chain (high import share of final output, limited local input suppliers). ### Employment, poverty, and inequality - Employment creation has been limited given narrow growth: - Subsistence farming employs over 40 percent of workers while only 10 percent of the land is suitable for cultivation. - Public sector employment growth decelerated after rapid hiring in the late 2000s; public hiring focused on low-skilled jobs and contributed to public sector inefficiency. - The textile industry generated substantial formal sector jobs for women, especially in the early 2000s, but employment has been declining in recent years, contributing to rising unemployment. - Social outcomes: - Poverty rates in Lesotho continue to exceed half the population, even as poverty rates declined elsewhere in SSA and lower middle income countries. - Lesotho ranks among the most unequal countries in SSA (fifth in the region). - Lesotho ranks in the bottom quartile of SSA income group peers in several health and education indicators; human capital indicators are broadly in line with the SSA median but far weaker than other low-middle income countries. - Literacy deteriorated by 7 percentage points over the last 15 years. - High maternal mortality rates, HIV prevalence, and low life expectancy point to weak access to quality health care. - Skill mismatches in the labor market indicate structural allocation problems of human capital. ### Export concentration and external instability - Exports are highly concentrated, contributing to external instability and growth volatility: - Textiles and diamonds have dominated exports. - Textiles and footwear represent 95 percent of exports to the US and 56 percent of exports to South Africa. ### Obstacles to private sector growth (growth diagnostic summary) - Using a Hausmann (2004) growth diagnostic, two major obstacles were identified: (i) the cost of finance is too high or (ii) the returns to investment are too low. The analysis points to low returns to investment as the more binding constraint. - Financial sector signals: - Loan-to-deposit interest spreads are very high in Lesotho compared with regional peers. - Lesotho’s private credit to GDP is relatively low; banks historically prefer to invest excess liquidity in South Africa, draining domestic savings out of Lesotho. - Return on equity of banks in Lesotho is the highest in the region but is derived largely from liquid assets rather than long-term loans to productive sectors. - Bank executives cite a lack of quality investment projects and weak contract enforcement that forces banks to add significant risk premia. - Social returns and infrastructure: - Human capital weaknesses (health and education quality problems, skill mismatches). - Infrastructure gaps: only 22 percent of roads are paved; Lesotho ranks 150 out of 190 in getting electricity in the World Bank Doing Business report. - Geography: landlocked with a small domestic market, but strong regional integration with South Africa offers market access. - Appropriability / government and market failures: - Political instability, weak public financial management, and a large public sector employer with a wage premium that disincentivizes private entrepreneurship. - Tariff and non-tariff restrictions (SACU common external trade policy and bilateral restrictions) raise costs for import-intensive industries. - Low productivity and innovation, limiting private returns; but export-oriented industries (mining, textiles) show potential to identify profitable businesses. ### Private sector perspectives - Private sector representatives identified major constraints consistent with the diagnostic: - Political instability, insufficient infrastructure, unskilled labor force, lack of quality standards, cumbersome government procedures. - Access to finance is a significant obstacle for small and medium businesses. - Perception that public employment crowds out private sector initiatives. ### Sectoral applications and potential growth opportunities - Tourism: - Tourism is labor intensive and could generate significant rural employment. - As of 2016, travel and tourism contributed more than ten percent of both GDP and employment in Lesotho. - Lesotho ranks poorly in tourism competitiveness (World Economic Forum ranked Lesotho 128 out of 136 countries in 2017) and has some of the lowest tourism receipts in the SACU region. - Constraints include lack of skilled labor, political instability, insufficient air and road networks, and poor roads. - Integration into regional and global value chains: - Proximity to South Africa provides opportunities to integrate into regional/global value chains (hub-and-spoke model for industries such as automotive parts and agricultural processing). - Integration could support employment and productivity by exposing firms to demanding standards and technical regulations. - Barriers: trade barriers, lack of political will, poor infrastructure, and low human capital that may limit upgrading within value chains. ### Policy implications and priorities - Complement capital-intensive projects with broad-based, employment-creating private sector growth to reduce volatility and support poverty reduction. - Authorities should prioritize reforms to promote private sector growth given limited institutional capacity. Key reform priorities include: - Improve the investment climate to raise returns to private investment (strengthen contract enforcement and reduce risk premia). - Address infrastructure deficits (road paving, electricity access) to lower transport and operating costs. - Improve human capital outcomes (health and education quality, address skill mismatches). - Strengthen public financial management and reduce political fragmentation that impedes reforms. - Facilitate access to finance for productive investments and SMEs while encouraging banks to channel liquidity into long-term lending domestically. - Use preferential trade access (e.g., AGOA) to support domestic supplier development and upstream linkages in export sectors. - Promote tourism development through improved transport connectivity, skills, and quality standards. - Pursue regional integration strategies to leverage proximity to South Africa and attract participation in regional/global value chains. *Prepared by IMF staff (Annex VII, "Growth in Lesotho: Strong, Narrow, Volatile, and Unequal").* ### 2016. The base year is 2012. The source data need to be improved, in particular, for the estimates of ### cr1854 - 2016. The base year is 2012. The source data need to be improved, in particular, for the estimates of ### Data and statistical issues - National accounts: - Base year is 2012. - Source data need improvement, in particular for the estimates of the expenditure side. - Poor quality of imports data has been a long-standing problem hampering the expenditure estimates. - Private consumption and gross fixed capital formation are now estimated independently. - A new Household Budget Survey (HBS) was started in 2017 and is expected to provide a new benchmark for household consumption as well as improved estimates of the informal sector. - Estimates of quarterly GDP by the production approach are being developed and are expected to be released in April 2018. - Price statistics: - The official monthly consumer price index (CPI), a composite of urban and rural price data, is available on a timely basis. - The CPI has been re-referenced to December 2016 = 100. - Work on developing producer price indices is ongoing; in the meantime, the national accounts rely on South Africa’s producer price index and import price indices. - Government Finance Statistics (GFS): - The Ministry of Finance compiles and disseminates GFS consistent with GFSM 2001 for the budgetary central government. - Monthly GFS for the budgetary central government are reported regularly on the national summary data page (NSDP). - Data quality issues remain, indicated by significant discrepancies between transactions above and below the line. - GFS for extrabudgetary units and local governments, and balance sheet data for any level of government, are currently not compiled. - Technical assistance by STA is supporting improvement of data quality and broadening the coverage of GFS, aiming to produce general government transactions and stock positions. - Monetary and Financial Statistics (MFS) and FSIs: - The Central Bank of Lesotho (CBL) reports monetary data regularly using the Standardized Report Forms (SRFs), with monthly data disseminated through the IFS. - Improved data sources enhanced classification and sectorization, but institutional coverage needs expansion to include other financial corporations. - Insurance companies have been trained on the MFS template and beginning January 2018 they will be reporting through the Banking Supervision Application (BSA). - Next phase of coverage improvement is pension funds. - The CBL has begun compiling consistent financial sector indicators (FSIs) from 2006 onwards. - FSIs on depository corporations are reported quarterly; FSIs on non-financial corporations, households, and real estate markets are not available. - Efforts are underway to compile FSIs for the insurance sector and real estate markets. - Balance of payments: - Since January 2017, Lesotho has improved timeliness of submitting BPM6-based balance of payments and (partial) IIP data to STA. - Further improvements are needed in coverage, methodological soundness, and consistency between the balance of payments and IIP. - A technical assistance mission is expected to be conducted in FY 2018. - The CBL is being assisted by the Macro-economic and Financial Management Institute (MEFMI) to undertake a private capital flow survey to collect financial account transactions and position data. ### Data standards, dissemination, and quality assessments - Lesotho participation and e-GDDS status: - Lesotho is a GDDS/e-GDDS participant since 2003. - Lesotho implemented the recommendations of e-GDDS in 2016. - It disseminates twelve of the fourteen relevant data categories needed for surveillance on its NSDP (a stock market is still being developed). This puts Lesotho in Baseline 2 of the e-GDDS thresholds. - Authorities are encouraged to disseminate the remaining data categories, general government operations and external debt, and improve periodicity and timeliness to move up the e-GDDS thresholds. - No Data ROSC mission has been conducted in Lesotho. ### Macroeconomic context and recent economic developments - Institutional and regional context: - Lesotho is a member of the Common Monetary Area (CMA) and the Southern African Customs Union (SACU). - Under the CMA, the loti is fixed at par with the South African Rand, which is also legal tender in Lesotho. - SACU provides for free movement of goods among members and a common external tariff. - Vulnerabilities: - Heavy reliance on SACU revenue and a relatively undiversified economic base magnify vulnerability to external shocks. - Volatility of SACU revenue complicates macroeconomic management. - The country is vulnerable to extreme weather conditions, including droughts and floods, which negatively impact the agricultural sector. - Historical shock: - In 2010/11, a sharp decline (47 percent relative to 2009/10) in SACU revenue induced a severe deterioration in both fiscal and balance of payments positions; government response included IMF Extended Credit Facility-supported actions. - Growth and inflation: - Lesotho’s economic growth: 2.4 percent in 2016. - A modest recovery is projected in the medium term to an average growth of 2.9 per cent, driven by services and a rebound in the primary sector (mainly mining); construction will benefit from Phase 2 of the Lesotho Highlands Water Project (LHWP II). - Year-on-year consumer inflation declined to 5.7 percent in December 2017, compared to 6.2 percent in March 2017. - A minor uptick in credit extension to both the private and household sectors was recorded. - Social and labor context: - Poverty, inequality and unemployment remain significant challenges. - Government is the largest formal employer and a significant client to the majority of the business sector. ### Fiscal policy, public financial management, and debt - Fiscal consolidation: - Authorities concur on the need to undertake fiscal consolidation to restore fiscal and macroeconomic stability, with spending cuts required; broad political consensus is needed given economic and social costs. - Consultations are focused on reducing the budget deficit for 2018/19 from about 6.9 percent of GDP by close to half through a combination of revenue and expenditure measures. - Tax administration and revenue: - Appointment of the new Board of the Lesotho Revenue Administration (LRA) is expected to strengthen governance and improve tax administration. - Following its inauguration in November 2017, the new Board resolved to lift the suspension of the Commissioner General of the LRA, expected to have a positive impact on revenue collection and management. - Public financial management reforms: - Authorities requested Fund FAD assistance to condense past TA recommendations into a reform plan to facilitate follow-up on outstanding actions. - Authorities prioritize implementation of the action plan. - Debt management: - Debt management strategy seeks to maximize grants and concessional financing, keeping the risk of debt distress low. - Authorities intend to rely on grant financing and concessional borrowing mainly to finance priority growth-enhancing social and physical infrastructure. - The decision by the US Millennium Challenge Corporation in December 2017 to re-select Lesotho as eligible to develop a second Compact is expected to boost the country’s development agenda. ### Financial sector development and inclusion - Financial soundness: - Lesotho’s financial sector remains strong with high soundness indicators and relatively low non-performing loans (NPLs). - Authorities monitor vulnerabilities including rising household indebtedness. - Structural challenges: - Low financial intermediation is a key structural challenge. - The financial sector is dominated by three banks — subsidiaries of South African banks — that are highly liquid and profitable but tend to prefer holding liquid assets to extending credit. - Staff’s suggestion that banks’ preference for holding net foreign assets (NFA) could be self-insurance due to absence of lender of last resort may not be accurate; banks’ behavior reflects the structural trade deficit with South Africa, shallow financial markets in Lesotho compared to South Africa, and perceived higher risk in Lesotho than South Africa. - Mobile money and supervision: - Mobile money has grown fast and provides a promising avenue to increase financial inclusion, particularly for rural populations. - Authorities will continue to monitor the sector for early detection and management of risks. - Authorities have made significant progress toward improving the supervision and regulatory framework and will continue efforts to seek legislative approval. - Financial sector data initiatives: - Insurance companies will begin reporting MFS via BSA from January 2018. - Work underway to expand coverage to pension funds and to compile FSIs for insurance and real estate markets. ### Private sector development - Strategic Development Plan: - The Government is developing the second version of the National Strategic Development Plan (NSDP II), following NSDP (2012/13-2016/17). - NSDP II prioritizes private sector development and identifies four sectors to drive job creation: agriculture, manufacturing, technology, and tourism and creative art. - National budget allocations are expected to be aligned with development of these sectors. - The Lesotho National Development Corporation is being restructured to better serve private sector development. ### Authorities' views and concluding points - Authorities appreciate Fund engagement and broadly concur with staff’s assessment of macroeconomic challenges and the need to maintain macroeconomic stability. - Authorities value Fund advice and agree on the need to implement fiscal consolidation to restore macroeconomic stability and generate sustainable growth, while acknowledging social and economic costs and the need for political consensus. - Authorities expressed concern that repeated references to delays or difficulties in policy consensus could be interpreted as political fragility, which may not be helpful in raising traction of staff advice given the prevalence of coalition governments. *Source: cr1854 - 2016. The base year is 2012. The source data need to be improved, in particular, for the estimates of* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1854.pdf_